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FHA’s Passivity Could Lead to Big Loan Losses

Gretchen Morgenson has an interesting story today about risky lending at the FHA AFTER the housing collapse. The story here is that, after the bubble popped, it became harder and harder to secure a loan. The FHA stepped in to insure a lot of what loans were made over that time, and as a result their 2009 and 2010 portfolio ends up being just as risky as you would expect in a pre-bubble portfolio. This is based on analysis from Edward Pinto of the right-wing American Enterprise Institute, but the FHA auditor has come to similar conclusions.

The new study of the potential risks in recent F.H.A.-insured loans is illuminating because it provides a level of detail, including where government-backed loans are, that is usually missing from agency analyses. In addition, the report’s loss estimates are somewhat surprising given that the loans it examined were made after the mortgage crisis became evident […]

To receive F.H.A. backing on their loans, borrowers must have a credit score of at least 580 out of a possible 850, and they are required to put down at least 3.5 percent. F.H.A. allows the borrowers whose loans it insures to have a monthly housing debt payment of around 30 percent of their incomes.

Still, 40 percent of the 2010 loans in the F.H.A.’s insurance portfolio were made to borrowers whose total monthly debt payments were greater than 50 percent of their monthly incomes or had a credit store of less than 660, the study found, a dangerous level.

The real problem is that the FHA appears to be an extremely passive organization. They do little in the way of monitoring the loans they insure, or adjusting their fees to properly reflect risk. Though they’re suing some major banks for poor underwriting in the loans they put in the FHA’s guarantee program, they basically accepted whatever the banks gave them. I don’t know whether or not the FHA needs to tighten its loan standards. But it absolutely needs to engage in more effective pricing of risk and something resembling adequate oversight.

This is not to say that the government should have no role to play in transitioning Americans toward home equity. It doesn’t mean that government organizations like the FHA or the GSEs caused the financial crisis, which I assume is Pinto’s underlying point in this analysis. But if we’re going to have these structures, they ought to be minimally competent.

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David Dayen

David Dayen